Risk Management vs Portfolio Management
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Questions and Answers

What is the primary focus of risk management?

  • Evaluating historical performance of assets
  • Selecting high-risk investment opportunities
  • Assessing and mitigating potential losses (correct)
  • Maximizing returns on investments

    • Which of the following best describes portfolio management?

  • Focusing solely on compliance with regulations
  • Creating and maintaining an investment portfolio to meet specific goals (correct)
  • Assessing the performance of individual securities
  • The process of managing investment risks

    • What is one use of marginal VaR in portfolio management?

  • To measure the total risk of the entire portfolio
  • To allocate resources effectively across different asset classes (correct)
  • To assess historical returns of individual investments
  • To eliminate all forms of market risk

    • Which of the following is NOT a type of risk typically distinguished in investment management?

    <p>Operational risk</p> Signup and view all the answers

    What does risk budgeting primarily involve?

    <p>Allocating risk across different investments or managers</p> Signup and view all the answers

    How does the turnover affect the risk management process?

    <p>Higher turnover may increase transaction costs and risks</p> Signup and view all the answers

    What is the main objective of performance measurement tools in investment management?

    <p>To evaluate the effectiveness of investments against specific benchmarks</p> Signup and view all the answers

    Which dimension is NOT fundamental to risk management?

    <p>Market sentiment tracking</p> Signup and view all the answers

    Which investor type is an exception to the assumption that all investors hold the mean-variance efficient portfolio according to the CAPM?

    <p>Investors who hold some of the risk-free asset</p> Signup and view all the answers

    Which of the following best describes a factor according to the context provided?

    <p>Regulatory audits</p> Signup and view all the answers

    What characteristic do assets that have losses during periods of low market returns typically have?

    <p>High betas and high risk premiums</p> Signup and view all the answers

    How does the expected payoff of an asset in bad times affect its expected return?

    <p>Higher expected payoffs lead to lower expected returns</p> Signup and view all the answers

    Which statement least likely describes a limitation of the capital asset pricing model (CAPM)?

    <p>Investors prefer risk-free investments exclusively</p> Signup and view all the answers

    What is generally believed about institutional investors in market contexts?

    <p>They often influence market prices significantly</p> Signup and view all the answers

    What is a common misconception regarding information in financial markets?

    <p>All investors have equal access to information</p> Signup and view all the answers

    Which of the following statements is true regarding market behavior?

    <p>Stock prices can exhibit asymmetries based on expectations of rising prices</p> Signup and view all the answers

    What does the APT model primarily focus on in relation to asset pricing?

    <p>Balancing risk and expected return</p> Signup and view all the answers

    Which theory posits that active managers help make markets more efficient?

    <p>Grossman-Stiglitz Theory</p> Signup and view all the answers

    What is a key assumption of the Efficient Market Hypothesis?

    <p>Market prices reflect all available information</p> Signup and view all the answers

    Which area is least likely to be exploited by active managers according to market efficiency theories?

    <p>Liquid market segments</p> Signup and view all the answers

    What do behavioral biases in trading typically lead to?

    <p>Market inefficiencies through underreaction or overreaction</p> Signup and view all the answers

    According to the APT model, what do investors require for bearing systematic risk?

    <p>Risk premiums</p> Signup and view all the answers

    In the rational explanation of behavioral finance, what compensates for losses during bad times?

    <p>High returns</p> Signup and view all the answers

    What effect do transaction, financing, and agency costs have in the refined EMH?

    <p>They introduce imperfections in market operations</p> Signup and view all the answers

    What is one significant risk associated with momentum investing?

    <p>Tendency toward crashes</p> Signup and view all the answers

    What can lead to an upward drift in stock prices according to behavioral explanations?

    <p>Delayed overreaction to good news</p> Signup and view all the answers

    Which of the following explains the rationale behind momentum investing?

    <p>Prices revert to their fundamental values over time</p> Signup and view all the answers

    Which investor behavior is associated with overreaction in momentum investing?

    <p>Overconfidence in performance attribution</p> Signup and view all the answers

    What should an investor consider when engaging in momentum investing?

    <p>Their inclination towards overreaction or underreaction</p> Signup and view all the answers

    What is a key assumption of the Capital Asset Pricing Model (CAPM)?

    <p>Investors have a single period investment horizon.</p> Signup and view all the answers

    What typically happens during 'crash' periods in momentum investing?

    <p>Central banks intervene in the market</p> Signup and view all the answers

    Which type of risk is NOT directly related to momentum investing?

    <p>Interest rate risk</p> Signup and view all the answers

    Which of the following is NOT one of the lessons from multifactor models?

    <p>All investors have identical investment preferences.</p> Signup and view all the answers

    Which strategy is most likely to stabilize asset prices?

    <p>Value investment strategy</p> Signup and view all the answers

    What does the stochastic discount factor (SDF) represent?

    <p>A single variable capturing all bad times.</p> Signup and view all the answers

    Which of the following concepts relates to Arbitrage Pricing Theory (APT)?

    <p>Some systematic factors require compensation through risk premiums.</p> Signup and view all the answers

    How is risk measured in multifactor models?

    <p>Using factor betas.</p> Signup and view all the answers

    What does the efficient market hypothesis (EMH) imply about active management?

    <p>Active management is generally not successful on average.</p> Signup and view all the answers

    According to multifactor models, what is true about valuable assets?

    <p>They have low risk premiums.</p> Signup and view all the answers

    Which of the following statements about market efficiency is accurate?

    <p>All investors have equal access to information at zero cost.</p> Signup and view all the answers

    Study Notes

    Risk Management vs. Portfolio Management

    • Risk management involves identifying, assessing, and prioritizing risks to minimize impacts on investments.
    • Portfolio management focuses on selecting and managing a collection of assets to achieve specific investment goals.
    • Both management types are critical in ensuring financial objectives are met while managing threats to those objectives.

    Marginal VaR in Portfolio Management

    • Marginal VaR (Value at Risk) measures the impact on the overall portfolio risk when adding an additional asset.
    • It aids in decision-making by identifying assets contributing to total portfolio risk.
    • This helps optimize asset allocation, ensuring that each investment aligns with risk tolerance and return expectations.

    Risk Budgeting in Investment Management

    • Risk budgeting defines how much risk to allocate to different investments based on their potential returns and volatility.
    • It allows fund managers to determine the expected performance per unit of risk across various asset classes.
    • Large investors, such as pension funds, use risk budgeting to align investment strategies with risk tolerance and capital needs.

    Horizon, Turnover, and Leverage in Risk Management

    • Investment horizon affects risk exposure; longer horizons may accept greater risks for potential returns.
    • High turnover in a portfolio can increase transaction costs and create volatility, impacting risk profiles.
    • Leverage amplifies potential returns and risks, requiring careful management to avoid significant losses in adverse market conditions.

    Types of Risks in Investment Management

    • Absolute risk measures the total risk of a portfolio without comparison to a benchmark.
    • Relative risk assesses risk in relation to a benchmark portfolio.
    • Policy-mix risk arises from changes in a fund’s investment strategy or asset allocation.
    • Active management risk reflects the potential underperformance of active strategies versus passive benchmarks.
    • Funding risk deals with the possibility of insufficient cash flow to meet obligations.
    • Sponsor risk is the risk associated with the financial stability and decisions of the sponsoring organization.

    VaR as a Risk Monitoring Tool

    • VaR quantifies the maximum expected loss within a specified confidence level over a set time.
    • It helps ensure compliance with investment strategies and risk limits established by management.
    • Portfolio managers can leverage VaR in rule development to manage risk more effectively.

    Risk Monitoring's Role in Investment Management

    • Risk monitoring involves ongoing assessment of risks to ensure that investment activities align with established goals.
    • It confirms adherence to investment strategies and identifies deviations from expected outcomes.
    • Effective risk monitoring contributes to an internal control environment, promoting consistency in investment practices.

    Performance Measurement Tools

    • Performance measurement tools evaluate the success of investment strategies against benchmarks and peer groups.
    • Alpha measures an investment's excess return relative to a benchmark.
    • Using benchmarks allows comparisons to gauge relative performance and identify strengths or weaknesses in the investment process.

    Market Efficiency and Behavioral Biases

    • The Efficient Market Hypothesis (EMH) argues that security prices fully reflect all available information.
    • Behavioral biases challenge EMH, indicating that investor psychology can distort market prices and trends.
    • Understanding behavioral biases is crucial in identifying market inefficiencies that can be exploited.

    Momentum Investing and Risks

    • Momentum investing capitalizes on trends by buying assets that have shown upward price movement.
    • Risks include exposure to market corrections during periods of high volatility and crashes driven by external factors.
    • Investors must balance the potential for gains against the risk of significant losses during downturns.

    Shortcomings of the Capital Asset Pricing Model (CAPM)

    • CAPM assumptions include homogeneous expectations and frictionless markets, which may not reflect real-world conditions.
    • The model does not account for investor behavior, such as overreaction or underreaction to market events.
    • It may also overlook transaction costs and taxes that affect real investment returns.

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    Description

    This quiz explores the critical differences between risk management and portfolio management, focusing on key concepts such as marginal VaR (Value-at-Risk). You will also learn how to implement marginal VaR in effective portfolio management strategies. Additionally, topics like risk budgeting and its implications on investment management will be covered.

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